Wednesday, April 23, 2014

Updated June 16, 2014The premiss of this posting is particularly pertinent given the recent rise in violence in Iraq which has pushed oil prices up to new yearly highs.There has a been a great deal of
speculation over the past half decade about the causes of America's housing
market crisis but a paper written by Steven Sexton, JunJie Wu and David
Zilberman from the UC Center for Energy and Environmental Economics provides us
with an interesting hypothesis.

Within the two year period between
2008 and 2010, over 4 million American families had lost their homes to
foreclosure and an additional 4 million families were "mortgage payment
challenged". As shown on this graph, households saw the value of equity
in real estate plunge from $13.4 trillion in the first quarter of 2006 to $6.09
trillion in the first quarter of 2009, a drop of 54.6 percent:

This brought the level of total
household equity in real estate to levels not seen since 1999. As a
result of the bursting bubble, one in four American households owed more
on their mortgage than the market value of their homes.

While we have a pretty good idea
that low interest rates, new mortgage products and easy credit that provided
mortgages for the less creditworthy among us fuelled the bubble, it is less
certain what actually triggered the housing market collapse.

Let's start by looking at national
gasoline prices for the United States. For much of the period between
1990 and the early 2000s when the housing boom was taking shape, world oil
prices remained relatively flat at around $30 per barrel in constant 2011
dollars and U.S. retail gasoline prices were below $2.00 per gallon in real
terms. The long period of low nominal gasoline prices over the period
between 1990 and the beginning of 2004 can easily be seen on this graph from FRED:

Over the 15 year period,
national gasoline prices averaged $1.19 per gallon, despite the price jump in 1999 from around $1.00 per gallon to $1.60 per gallon.

The situation began to change right
at the beginning of 2005, the last time that the United States saw gasoline
sell for less than $1.50 per gallon. As shown on this chart, between the
beginning of 2004 and September 2008, gasoline prices began a steady climb,
peaking at $4.11 per gallon in July 2008:

During this nearly five year period,
gasoline prices averaged $2.56 per gallon.

Now, let's get back to housing.
The authors note that post-World War II housing growth in the United
States was related to a decline in city centre population and an increase in
the population of the suburbs. This was largely a result of the advent of
the automobile that makes it easier for those living in the suburbs to commute.
The result of the move toward both suburban and exurban areas resulted in
this:

Between 1971 and 2007, total vehicle
miles travelled rose from 1.13 million miles to 3.04 million miles, an increase
of 169 percent. All of those miles travelled require household expenditures on
gasoline.

While some suburbanites prefer to
commute by public transit, a 2004 study showed that time savings for car commuters
were substantial; in the year 2000, a median car commute took 24.1 minutes
compared to a median transit commute of 47.7 minutes. Urban sprawl
is very closely correlated with car ownership rates. If cars are being
used for commuting, obviously, households are spending money on gasoline.
Here is a graph showing U.S. household
expenditures on gasoline in nominal dollars and as a percentage of mean
household income:

Notice the rapid rise in household
expenditures on gasoline between 2004 and 2008? That is the key to the
author's thesis. Household expenditures on gasoline rose from $1600 in
2004 to $2700 in 2008, a 69 percent increase. While the extra $1100 spent
on gasoline by an average household is not terribly punitive, it is the impact
of higher fuel costs on the marginal households that are most severe.
According to the authors, in some cases, workers in California saw their
annual commute costs rise to nearly $10,000 annually, a very substantial
portion of total household annual expenditures. The lowest income
quartile households that have the longest commutes or that have older model,
less fuel-efficient vehicles suffered the most from rising gasoline prices.
The authors note that, in general, the median household income of
households located within 120 kilometres of a high employment density city
declines one-tenth of one percent per kilometre of distance from the city
centre. This means that, in general, lower income households have the
longest commutes and are most susceptible to gasoline price changes. It
is these very households that availed themselves of the banking system's no
downpayment, interest only mortgages, making them the most vulnerable.

The authors analysis uses
California's experience during the housing market implosion to illustrate their
analysis. California has 25 percent of the housing value in the United
States. In 2010, the state accounted for nearly 20 percent of the nation's
foreclosure filings and by 2009, one in three mortgagees in California was
underwater. Seven of the nation's top twenty highest foreclosure rate
markets were located in California, all in outlying areas including Modesto,
Riverside-San Bernardino and Stockton. California cities that saw the
highest percentage declines in median price were located farther from major
cities and three things in common; longer commutes, higher vehicle miles
travelled and higher gasoline expenditures. The fifteen cities that fared
the best during the price "readjustment" were much closer to major
cities and had incomes that averaged 125 percent higher than their less
well-off peers and had gasoline expenditures that were lower as a percentage of
household income.

What is interesting to note is the
rise in household expenditures on gasoline since 2010 as you can see on the
graph above. In 2009, households spent $2000 on gasoline; by 2012, this
had risen to a new peak of $2900, an increase of 45 percent in four years. This
has happened at the same time as house prices in many cities in California have
risen to levels that are not substantially below the levels seen during the
peak of the real estate bubble and at the same time as gasoline prices hover around the $3.50 per gallon level. Another factor that has to be considered is the fact that real wage growth in the United States has been very low over the past decade: this means that gasoline price increases are not being met with increases in household income.

In general, economists agree that
there is a direct link between energy prices and economy growth and that high
energy prices are transmitted through an economy, impacting unemployment and
GDP. This study shows that the rise in gasoline prices between 2004 and
2008, in particular, may well have had a direct link to the collapsing of the
real estate market.

4 comments:

Canadian gasoline prices have been at least $5 per US gallon for years and are currently close to $6 according to one report I saw. Americans have the cheapest gas in the world and are constantly bitching about the high price of gas. How can one possibly spend $10,000 of gasoline in a year? Even when I drove a full sized van with a V8 that got 16 mpg I never spent even half that.

Well said, the quick math would have these people commuting to work well over 100 miles a day. This does happen, but in all reality it is a bit stupid except in the rarest of cases. Strange as it seems many Americans see this as acceptable and normal.

For years I have looked for a links between a commodity like the cost of a loaf of bread to housing. Your link to gasoline moves in the same general direction. Based on supply and demand over the short-term these links appear elastic, however linked they are. Below is another look into some of the places where inflation is hiding.http://brucewilds.blogspot.com/2013/06/inflation-lurks-beneath-and-hidden.html

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About Me

I have been an avid follower of the world's political and economic scene since the great gold rush of 1979 - 1980 when it seemed that the world's economic system was on the verge of collapse. I am most concerned about the mounting level of government debt and the lack of political will to solve the problem. Actions need to be taken sooner rather than later when demographic issues will make solutions far more difficult. As a geoscientist, I am also concerned about the world's energy future; as we reach peak cheap oil, we need to find viable long-term solutions to what will ultimately become a supply-demand imbalance.